PJM Asks of FERC: Abandon Basic Economic Principles RSS Feed

PJM Asks of FERC: Abandon Basic Economic Principles

In its recent comments at FERC on the DOE proposal, PJM floated an idea that would inflate electricity market prices, particularly for large, inflexible, coal and nuclear power plants at times when they are least needed but can’t turn down their output. If PJM has its way, it will fast track a sweeping change to its market rules without real input from stakeholders. Generators benefiting from this proposal have chimed in with their hired “experts” in support of the idea and have conveyed to their shareholders the profits they’d reap and how they would push very hard to get the changes quickly implemented.

But a group of PhD economists whose role is to ensure the integrity of the electricity markets—the market monitors overseeing FERC-regulated markets in the Mid-Atlantic, Midwest, parts of the Great Plains, and New England states, as well as California and New York—uniformly and vehemently oppose PJM’s idea. PJM’s detailed proposal is scheduled for release on December 7. Here are some reviews of PJM’s initial concept so far:

“[H]ighly inefficient and destructive to existing energy markets in the Eastern Interconnection”


“[I]nconsistent with the economic fundamentals underlying efficient [spot] markets and would critically undermine the pricing and dispatch of the wholesale electricity markets”


“A broad adoption of [PJM’s proposal] would undermine the PJM market’s fundamental focus on achieving the competitive market result”


“Under PJM’s proposal, [market prices] will no longer reflect the optimal prices at which both buyers and sellers want to consume and supply the quantities of goods”


What is PJM’s rotten tomato of an idea?
PJM’s proposal will enable large, inflexible coal and nuclear power plants unable to lower their energy output below a certain minimum threshold to be able to fold in “fixed costs” into their market bids. While this sounds innocuous, the idea violently conflicts with the most fundamental conclusions of economic theory: that competitive markets achieve the efficient result when suppliers offer their goods at their marginal cost (the incremental cost incurred to produce additional output). In other words, by charging the marginal price to consumers and paying that price to suppliers, everyone is motivated to produce and consume goods efficiently.

Grid operators decide which resources to dispatch to meet electricity demand every 5 to 15 minutes at every location on the grid. Flexible resources can alter electricity output during these short time frames to match demand.

But large, inflexible power plants may need days to start up (i.e., a much longer time horizon than 5 to 15 minutes). These power plants also cannot run under a minimum energy output threshold, even if consumers demand less than that threshold. The costs associated with start-up and minimum generation levels are therefore “fixed costs” and are not marginal for providing additional energy. Only the power plants’ costs of supplying additional energy above their thresholds can be marginal.

(And lest you fret for the poor old, inefficient, lumbering coal and nuclear power plants, they do receive separate “out-of”market” payments for these “fixed costs.”)

PJM’s proposal abandons this fundamental economic principle by departing from using marginal costs to set market prices. No one has done this before, and no one fully understands the consequences (which weighs in favor of not fast-tracking the proposal). Some preliminary concerns are as follows.

PJM’s proposal could inflate electricity prices for consumers
PJM’s market monitor estimates that PJM’s energy market prices could go up by around 15 percent. That translates to roughly $3 billion dollars per year. The market monitor for MISO estimated how PJM’s proposal would have impacted that region’s prices over the course of the past year, and showed that its energy market prices would have increased by roughly 30 percent.

PJM’s proposal could mute market signals to flexible resources
PJM’s proposal would include “fixed costs” of power plants in market prices even at times when demand is below the plants’ minimum electricity output. Effectively, this would establish a price floor at an averaged-out level for the power plant, even when there is too much supply on the system and efficient prices would be very low or even negative. Setting a price floor masks the signals to flexible resources that the market would normally convey via prices. For example, low or negative prices can signal energy storage, electric vehicles, and grid-connected water heaters to charge, alleviating demand from these devices when the grid is stressed and electricity use is at its peak.

PJM’s proposal would create market gaming concerns
Because PJM’s proposal creates prices that do not represent actual marginal costs, it also creates incentives for suppliers to deviate from their optimal level of energy production and to offer prices that do not represent their true costs. Depending on the proposal’s details, it could incent suppliers to overbid their fixed costs and underbid their marginal costs to maximize revenue for themselves without providing anything different for consumers.
Read full article at NRDC